Business firms, whether operating domestically or internationally, are certainly exposed to risks of unfavourable movements in their profits resulting from unexpected movements in exchange rates. Fluctuation of exchange rates gives rise to foreign exchange exposure and foreign exchange risk. Nevertheless, these terms are often used interchangeably, in actual they represent two different, yet closely related concepts.
Exposure alludes to the degree to which a company is contrived by exchange rate changes. In other words, it’s the sensitivity of the real home currency value of an asset, liability or an operating income to an unanticipated change in the exchange rate, assuming unanticipated changes in all other currencies as zero. It is calculated by regression. Exchange rate risk is defined as the changeability of a firm’s value due to undetermined changes in the rate of exchange. In other words the Variability of the domestic currency values of assets, liabilities, operating incomes due to unanticipated changes in exchange rate. It is calculated by variance or standard deviation.
Foreign Exchange Risk & Exposure is classified into;
Transaction exposure results from a firm taking on fixed cash flow foreign currency denominated contractual agreement. For instance, if a firm has entered into a contract to sell computers to a foreign customer at a fixed price denominated in foreign currency, then the firm would be revealed to exchange rate fluctuations till it receives the payment and converts the receipts into the domestic currency.
Translation exposure is also called accounting exposure, results from the need to restate foreign subsidiaries financial statements, usually stated in foreign currency, into the parents’ reporting currency when preparing the consolidated financial statements. Although translation exposure may not affect a firm’s cash flows, it could have a decisive impact on a firm’s disclose earnings and therefore its stock price.
Operating exposure is also called economic exposure, results from changes in the amount of future operating cash flows caused by exchange rate change. Resulting in gains or losses determined by changes in the firm’s future competitive position and is real. Therefore the impact of operating exposure is on revenues and costs associated with future sales.
Foreign exchange risk is classified into;
Financial Risk refers to unexpected events in the country’s financial, economic, or business life. Examples of financial risks are currency risk, interest rate risk, inflation risk unexpected changes in the balance of payment etc.
Political Risk is the risk that a sovereign host government will unexpectedly change the rules of the game under which the businesses operate. Examples are expropriation risk, disruption in operations, protectionism, blockage of funds, loss of intellectual property rights etc.
Country Risk can be classified into Macro risk and Micro risk. Macro risks upshot all firms in a host country. Micro risks affect specific to an industry, firm or project in a country.
One can manage foreign exchange risk and exposure through risk management tools like hedging, forward contracts, currency futures, currency options, and currency arbitrage. Myforexeye provides access to state of the art advisory services on a single tap, by making it the most convenient technique to manage foreign exchange risk and exposure.
Read more about Foreign Exchange and Risk Management
17 Aug 2019 10:55 AM
Foreign Exchange reserve is an essential component of any Nation's economy health in balance and for India which is an import driven country, it helps keep GDP level...
13 Aug 2019 04:17 PM
Popular Hedging tools used by forex experts to mitigate currency risks include currency options, futures, forward, swaps. Options and futures differ from one another.
08 Aug 2019 06:07 PM
In the area of forex services buying and selling, it involves unpredictable risks due to the volatility of the forex market. Before making any transaction, the Forex experts generally make use of the signal system in order to make any decisions.
06 Aug 2019 03:10 PM
The foreign exchange market is a truly global market. So even if there is a slightest movement in the geopolitical and economic factors, it is bound to directly affect the rate of currencies.
01 Aug 2019 05:35 PM
Forward contract is one of the most straight forward currency hedging methods. They are basically traded “over the counter” (OTC) between two parties, rather than through a public derivatives exchange.
30 Jul 2019 04:41 PM
Just as high rate of inflation negatively impacts the currency exchange rate, similarly, prolonged low rate of inflation also does not guarantee a favourable exchange rate.